There are some very high dividend yields available in the UK stock market at the moment. A variety of shares even offer double digit annual yields in percentage terms. But some appeal to me more than others as possible additions to my portfolio. I have been considering a couple of income shares lately, which yield 12% and 16% respectively. But I like one more than the other. Below I explain why.
High-yield dividend shares
Before revealing the identity of the companies, I will describe some of their features.
One buys up old gas wells in the US and sells the energy from them. With energy prices riding high, that could be a very lucrative business model. The company has been actively buying thousands of such wells that are no longer economic or strategic for large producers but have gas left in them. That could turn out to be a stroke of deal-making genius.
It pays dividends quarterly and has a track record of raising them over the past few years. But one risk I see in addition to unpredictable energy prices is the possible costs of decommissioning tens of thousands of aging wells as they reach the end of their working life.
The other company operates on this side of the Atlantic. It builds and sells houses. The company’s business model means it typically has attractive profit margins. Last year, for example, its net profit margin after tax was around 22%. This year, average selling prices have risen but in the first half, sales volumes slipped compared to the same period last year. A key risk I see is the UK housing market losing steam, which could hurt both sales and profits.
Who’s who
The first company is Diversified Energy (LSE: DEC) and currently yields 11%. The second is Persimmon (LSE: PSN). It now yields an eye-watering 16%.
Both of the companies clearly face risks that could lead to lower dividends in future. One thing that unites them is that profits could be hurt due to a cyclical risk of falling prices, whether in energy or homes.
Despite that, of the two shares, the one I would consider buying for my portfolio is Persimmon. Why?
Weighing risks and rewards
In short, both shares carry sizeable risks. But I think the risk-to-reward ratio looks better at Persimmon than Diversified.
Persimmon has proven its business model over the course of decades. Housebuilding as an industry has long roots, although it does also throw up quite a few business failures when demand falls. Diversified is a much newer company and its business model is innovative. That means it could turn out to be surprisingly lucrative — but there is also a risk it is not sustainable, for example when wells are due to be capped.
Despite its beefy dividend, Diversified has recorded an accounting loss in the past couple of years. By contrast, Persimmon’s post-tax profit last year topped three quarters of a billion pounds.
Often a substantially higher yield can signal elevated risk. Although Persimmon’s yield is higher, I am actually more comfortable with its risk profile as a fit for my personal investment objectives than I am with that at Diversified. So of the two shares, the one I would consider buying today for my portfolio is Persimmon.
